 Income tax 2022-2023, business expenses, pension plans. Let's do some wealth preservation with some tax preparation. Support Accounting Instruction by clicking the link below giving you a free month membership to all of the content on our website broken out by category further broken out by course. Each course then organized in a logical reasonable fashion, making it much more easy to find what you need than can be done on a YouTube page. We also include added resources such as Excel practice problems, PDF files and more like QuickBooks backup files when applicable. So once again, click the link below for a free month membership to our website and all the content on it. Most of this information comes from the tax guide for small business for individuals who use schedule C publication 334 tax year 2022. You can find on the IRS website irs.gov irs.gov. Looking at the income tax formula we're focused on line one income. Remembering the first half of the income tax formula is in essence an income statement but just a scaffolding and outline other forms and schedules flowing into these line items. One of those being the schedule C having business income minus business expenses. The net business income flowing from schedule C to line one income of our income tax formula. The first page of the form 1040. Remembering the schedule C flows into the schedule one which flows into the first page of the form 1040 line number eight. The profit and losses is the schedule C profit or loss from business and it's formatted as an income statement. In essence, having income section and expense section were focused on the expenses at this time specifically with related relation to pension plans. Okay, so we've got the pension plans. You can set up and maintain the following small business retirement plans for yourself and your employees. So we've got the SEP. We've got the simple. We've got other qualified plans. So note the general thought process often happening for small businesses would be now I have a sole proprietorship type of business. If I were an employee, one of the big benefits you often get when you're a W to employee as opposed to a sole proprietor is a 401k plan or something like that. The reason that's such a big benefit is because you can put money into a retirement type of plan and that you have tax benefits related to the retirement plan. You also could have some matching involved with it as well. Now I do want to point out that oftentimes when people think of these kind of retirement plans, they kind of feel like they start to think and imagine of these plans as being separate or different than ordinary or normal investments. They're like thought of as plans that are like government constructed retirement plans that we're putting our money into or something like that. That's not really what they are or how I would think about them. Usually we're putting money into some kind of mutual fund and even if we didn't have any tax benefits, even if we didn't have like a 401k or an IRA or anything like that, we would still want to put money away for retirement using the tools that are out there these days, which are normally the mutual fund types of tools which allow us to pool money together and invest in stocks and bonds for retirement. That's the general concept. So where does the 401k come into play? Why would we put it under a 401k? Well, the 401k you might think of as kind of like an umbrella over the top of the normal investment tool of these types of mutual funds general. That's the structure that's going to be used and they actually restrict you. The umbrella does the 401k, for example, from taking the money out early, but in exchange for that restriction, they allow you the tax benefit of putting the money in up front. So you're going to put the money in whenever we're thinking about these kind of retirement plans, similar thing with an IRA. We get a deduction when we put the money in or we get a tax benefit when we put the money in and then when we take the money out, we usually have to pay taxes at the point in time that we take it out. So it's kind of like a deferral type of situation. So that's the general idea with the 401k similar thing with the IRA. If you are not an employee of an employer that has access to a 401k plan, you could put money into an IRA, but the amount of money you can put into an IRA is much less than it is for like a 401k type of plan. So as a sole proprietor, you might say, well, I have some cash flow, I want to put more than I can put into, say, an IRA maybe. So then you might think about setting up your own kind of pension plan. Normally you wouldn't want to like a 401k plan because that's going to be quite burdensome to manage a 401k plan for a small business oftentimes. So you might think of some other alternatives for small businesses, both for yourself so that you could put more money in as well as for the employees. And you have to keep in mind then what are the rules for the plan in terms of how much I can put into the plan for myself, for this plan as the owner of the schedule C small business. And what are the rules for the employees that I'm required to put in for the employees and that I can put in for the employees. Okay, so instead of having a 401k because that's usually going to be quite complex, the two main options for a small business is like a SEP or a simple. So once you've come to the conclusion of saying, now I have, I want to put more money in than I have in an IRA. And then you can then you can go into the thought process of looking into a SEP or a simple and looking at the pros and cons of those types of plans and possibly other qualified plans that you can look into as well. One of the benefits being that you can put more money in than you can from an IRA and you can also give some benefit to employees in that case. Now the SEP, the simple employee pension plan, I think also has another benefit to it, which is that you might be able to put money in not just simply in the tax year that for 2022. In other words, you might not have to put the money in in 2022, but possibly could do some planning after the year has ended to see how much money you can put in to the plan. Because if you do tax preparation, you might come into the situation that the IRA is often the last question that you might ask somebody because whether or not they can put money into an IRA might be dependent upon other factors. So luckily, fortunately, the tax code allows us to put money into an IRA if we're allowed to past the due date or the end of the year, past December 31, 2022. In the tax year 2022 case, up until the point in time that we do the tax return is due April 15 or 17 or whatever the tax due date is. And that allows us to process the tax return and see how much we can maximize the IRA, which is great. If you're a small business, this SEP is often going to be limited as well to how much income you have. So it would be nice oftentimes to once again be able to calculate your taxes and then be able to determine how much you're able to be putting money into a SEP. So notice as a tax preparer, if you're dealing with people with a schedule C, then this is something you kind of want to keep in mind as a topic that will probably come up if the business starts to be profitable. If they have positive cash flow, then they might want to put money away more than they can put away into say an IRA. And that usually goes into an exploration of the possibility of a SEP or a simple and you can then explore those those options. Okay, so SEP simple and qualified plans offer you and your employees a tax favored way to save for retirement. You can deduct contributions you make to the plan for your employees online 19 of schedule C. So when we're talking about the amount that's going to be put away for the employees, that's part of of the business, you know, benefits. So that's going to be a normal, ordinary, necessary deduction on the schedule C. If you are a sole proprietor, you can deduct contributions you make to the plan for yourself on line 16 of schedule one form 1040. So we end up with the same kind of situation. And I would still, I think the best way to imagine this is to try to say, okay, if I was an employee employee or situation, how would things form formulate? And then if I'm a sole proprietor, where the government is once again kind of treating me as if I'm an employee and employer of myself by charging me social security and Medicare. How is it going to work in that case? How have they adjusted the tax code? In other words, if it was a corporation, which was a separate legal entity that was paying an employee, then the corporation would be able to deduct the amount that they put into the retirement plan, which we can of course do for our employees. But what about the amount that I put into the retirement plan for myself? You would think I'm, even though I'm not paying myself wages, I'm not processing W2 wages for myself. You're still treating me as an employee of myself because you're charging me social security and Medicare. So you would think that they would allow me a deduction for the amount that I put into the retirement plan, the SEP or simple or whatever. But you don't get it on the schedule. So you do. You don't get it on the schedule C though. It's on the schedule one. It's going to be the above the line type of deduction for income and above the line type of deduction. That also helps to do the calculation and figure out how much you can put in because there's going to often be limitations on how much you can put in based on the amount of income you have. Oftentimes what you want to have at the end of the year on the small businesses have significant cash flow that you are able to put in to a retirement plan and then try to figure out the maximum you can put into a retirement plan if you have the cash flow to do that. Obviously tax planning oftentimes is dependent upon whether or not you have the cash flow to do it. So you can also deduct trustees fees and contributions to the plan. Plan do not cover them. Earnings on the contributions are generally tax free until you or your employee receive distributions from the plan. So it's similar to an IRA. It's similar to a 401k plan. You're getting a benefit upfront. You're restricting your money by putting them under this umbrella similar to an IRA and a 401k plan so you can't take the money out in exchange for the tax benefit that you're going to be getting. So you may also be able to claim a tax credit if you begin a new qualified defined benefit or defined contribution plan including a 401k plan simple plan or set plan. The credit equals 50% of the cost to set up and administer the plan and educate employees about the plan up to a maximum of $500 per year for each of the first three years of the plan. So obviously setting up, it depends how complex the plan is. So obviously a simple and a set are a lot more easy to set up than a 401k plan but a 401k plan has more flexibility and benefits in it. So you have to think about setting it up and administering the plan. Under certain plans employees can have you contribute limited amounts of their before tax pay to a plan. These amounts and earnings on them are generally tax free until your employees receives distributions from the plan. That's another tax benefit. So for more information on retirement plans for small businesses see publication 560. So if you're in a situation where you want to dig into these and do some comparing and contrasting and see which plans would best suit you. You can dive into that publication. Some of the general things you're looking for oftentimes are going to be, you know, am I allowed to kind of figure the calculation that I'm going to put in personally after the tax year has ended, which can really help for planning oftentimes for small businesses. What's the maximum that I can put in? Can I do some kind of matching situation? And so those are going to be the some of the general kind of things you want to be comparing and contrasting how much administration fee, how much does it cost to administer the plan and what are the requirements if I have employees for the contributions for the employees? What's the bottom line requirements that I have to do and what's the top line requirements that I have to do for the employees? Because sometimes people set them up focusing on the employees as the main reason. Other times they're setting it up focused on your own contributions because you're trying to increase your contributions over what you could put in to a general IRA. Tip! Pub 590A, which you can find on the IRS website, Contributions to Individual Retirement Arrangement IRAs discusses other tax-favored ways to save for retirement.